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Detroit reaches new settlement in swaps contracts termination

Swaps deal/Barclays loan: Like refinancing a house?

Though the technical details of the municipal deals are more nuanced, a house refinancing is a good analogy. Homeowners who took out a mortgage when rates were high thought they were getting a good deal. Today, though, rates are lower and terms better so they want to refinance their homes. Doing so lets them pay off the high-interest debt and secure a new loan at a cheaper rate, allowing them to use the savings to pay other bills. Of course, when you refinance your house you usually don't have creditors waiting in line for your newly freed up cash, which is the case for Detroit.

The city of Detroit reached a new settlement in its bid to terminate interest rate swap contracts with UBS AG and Bank of America Corp.

Under the agreement presented to Gerald Rosen, chief district judge of the U.S. District Court for the Eastern District of Michigan and lead mediator in the bankruptcy, the banks will allow the city to terminate its contracts for $165 million, a 43 percent discount.

Originally, the city and the banks had agreed to $220 million to terminate the interest-rate swaps that have cost the city about $202 million since 2009. That was a 25 percent reduction off the $293.3 million the city owes on the secured debt.

The deal still must be approved by U.S. Bankruptcy Judge Steven Rhodes, who is scheduled to review it and the post-petition financing at a hearing on Jan. 3.

"This is an important development for the city and its residents because it means we can start moving forward on implementing needed investments in public safety and services," Detroit Emergency Manager Kevyn Orr said in an emailed statement. "This agreement represents a significant reduction from the original deal struck with the banks. The banks and the City, through mediation, and with the mediator's recommendation, have accepted the reduction in terms."

To pay for the deal, Orr and his team had secured a $350 million loan through Barclays. Because of the reduction in the amount owed to the swaps contracts, Orr said the city will reduce that loan to $288 million. The balance of the loan will be used to fund improvements to city services, he said.

Additionally, the deal gives the city back its casino revenues, which Orr has said is the city's most stable income stream. The money — worth up to $15 million per month — was tied up as collateral in the interest-rate swaps deal that was negotiated in 2005.

What the new deal could mean for the remaining creditors is unknown, but Patrick O'Keefe, CEO of Bloomfield Hills-based turnaround consulting firm O'Keefe LLC, thinks it could be positive news.

"Arguably for the creditors, they should like this better because there is less of an encumbrance of the future cash flow," he said. "The next issue for the creditors is, should all this money go to city services? Why shouldn't some of it come to them? That might be the next fight for Orr. He may need to prove that [the Barclay] money is required for the sustainability of the city."

And there is no guarantee that the deal will get approval from Rhodes, as Judge Rosen mentioned from the bench:

"Of course, all parties understand here that Judge Rhodes is not bound by this," Rosen said in the court transcript. "I think it's fair to say he's expressed that he has some reservations about some of the claims, and it will be up to him to determine whether or not this is a fair and equitable settlement for the city and for the SWAP counter parties, but we will make a mediator's recommendation to that effect."